Incumbent managers have a natural advantage with mature pension funds in the provision of solution-type services, finds Pádraig Floyd
Fiduciary management, implemented consulting, outsourced CIO services and the like have received much publicity in recent years. Yet while fiduciary management accounts for more than 90% of Dutch pension assets, it represents just £60bn (€75bn) of UK defined benefit scheme assets, or less than 3% of the total, according to a 2013 KPMG study. In other countries, it has barely scratched the surface in terms of recognition, let alone market penetration.
Fiduciary management is better understood in the context of a wider move towards the provision of solutions to institutional investors. ‘Solutions’ is a term that can mean many things. Indeed, as all investment strategies have a target of some kind, almost anything might be considered a solution.
But this is not the case, says Nigel Birch, a director at London-based consultancy Spence Johnson. “We look at investment solutions as encompassing defined benefit solutions covering fiduciary management, partial solution management and shades of that across multi-asset and liability-driven investment solutions,” he says.
So what is a solution and what isn’t? Multi-asset should not include diversified growth funds (DGF), according to Spence Johnson. DGFs are designed to meet a general outcome such as diversification or equity-like returns with two-thirds volatility and are not a solution as such.
But a target-date fund would be an investment solution in Spence Johnson’s book as it is created as a bespoke offering for the employer.
The market is evolving towards outcome-orientated solutions, says Birch, due not only to demand from pension funds but also for less altruistic reasons. As UK funds reach full funding, they will not change managers frequently and incumbent managers will have a natural advantage: “There is a race for these assets now,” as Birch puts it.
What’s in a solution?
“They could see a number of liquid opportunities but didn’t have the internal resources, even with an independent investment team of eight,” says BlackRock’s head of UK strategic clients Andrew Tunningley. “We had identified a way to build an inflation-linked growth fund using illiquid assets, such as infrastructure debt, long-lease property and so on – both BlackRock and external – to provide inflation linkage and returns in excess of credit spread.
“We created it as a fund so the underlying schemes could get exposure, and I don’t think this type of fund existed until now. Environmental, social and corporate governance was important and we had to meet sustainability hurdles as well.”
• Amundi’s investment platform for an insurer
An insurance company asked Amundi to set up an investment platform covering its different international subsidiaries across several continents in order to centralise the risk monitoring of its global portfolio of assets.
“We drive the agenda of a monthly investment meeting for this client, reporting on portfolio performance and risk, sharing our investment views and defining strategy for the coming months after simulating the impact of set scenarios on the client’s risk profile and accounting,” says Eric Tazé-Bernard, chief allocation officer at Amundi.
“These mandates have been delegated to external managers, using our manager selection platform. In this case, Amundi’s specialist managers were selected for the management of a cash mandate in recognition of rating constraints set by the client on this asset class, where the manager’s solidity and risk-management capacity is vital.
“We also set up a strategy dedicated to pension funds whereby asset allocation is defined not only on the basis of our present investment policy but also on the pension fund’s funding ratio target compared with its present situation and a minimum acceptable level. The returns generated in these cases are essentially dependent on the client’s specific constraints.”
• JP Morgan Asset Management as outsourced CIO
JP Morgan was appointed to manage a total return mandate on an outsourced CIO basis from the US retirement industry in early 2013.
The mandate – a more than $1bn (€760m) multi-asset portfolio that represents around 50% of a pension plan – is one of two mandates through which all assets have been outsourced to two firms with different styles.
Allocations are across asset classes, liquidity profiles and exposures to public and private markets, and the objective is a target 7.5% total return to be managed as if JP Morgan Asset Managment were ‘in the client’s seat’.
Some people think pension funds are now getting better value from their service providers than was previously the case; and so they should, says Mike O’Brien, global head of institutional business at JP Morgan Asset Management. “We used to give clients Lego bricks and say, ‘You build it for me and I’ll help you execute it’. But clients have said they are done with doing it themselves.”
This requires a new approach that employs greater engagement. O’Brien says: “It is more about listening than selling and is based on outcomes rather than performance. It requires a different skill set, which values engineering – how you actually build things – as much as alpha. You have to understand the environment clients are working in and what they are trying to achieve.”
This is not just another marketing fad. Pension funds are maturing and they increase in sophistication as their needs evolve.
“The demand is increasing as clients require solutions, not piecemeal but as an end-to-end solution for the concrete challenges they have,” says Jörg Ambrosius, head of asset manager solutions for the EMEA region at State Street. “Pension institutions also welcome the opportunity to outsource individual risks to others because of the personal risk to trustees, giving the trustees more confidence having done due diligence.”
Ambrosius believes asset allocation decision-making is crucial and says the most important thing is to satisfy the client’s requirements while providing transparency.
This raises the question: who is better placed to deliver investment solutions – asset managers or the consulting firms that have developed investment solutions businesses?
For Ambrosius, consultants have moved into this area because of a simple need for survival in an environment in which they are increasingly called upon to justify their recommendations, without the rich pickings of yesteryear.
But that does not mean consultants don’t have a role to play. “Consultants have some skills that managers lack,” says Ambrosius. “For instance, it is much easier to switch providers if something goes wrong when you are not tied to a single provider.”
John Walbaum, head of investment consultancy at Hymans Robertson in the UK, is not convinced by providers on either side of the divide. “We come at this with a healthy degree of scepticism,” he says. “They claim they can manage the conflicts and that’s true, but why introduce a conflict where none existed before? Trustees should be in control and should have intellectual skin in the game. Control really matters in the big things, such as overall strategy and asset classes.”
Determining just how well a provider has performed is not easy. These mandates are bespoke to the specific requirements of a single scheme, making direct comparisons difficult. There is no simple answer to that, says Michael Schlachter, head of the multi-asset class solutions group at Prudential Investment Management.
“How do you assess whether an accountant, barrister or lawyer is doing a good job? The criteria are ambiguous. Is it thought leadership? Timely intervention, providing the right answer at the right time? There is no easy way to benchmark and firms are trying to find ways to provide clients with a sense of success along the journey, which will require some extra engagement.”
In an effort to solve this conundrum, consulting firms such as Hymans Robertson offer a service that validates and monitors the provider. There is some sense in this, says Ambrosius, who believes administrators such as his, alongside other third parties, can bring expertise to the measuring of performance. He says: “Does it really make sense to have an asset manager that provides a solution as well as measuring the performance that drives compensation?
“This may lead to a break-up of the value chain, where neutral parties can focus on measuring results and indicating outperformance – not just a market benchmark – to offer a more holistic view.”
Schlachter says consultants may not be equipped to manage a bespoke partnership solution involving several providers. “They may offer good ideas and provoke thoughts on a different perspective but they think in terms of a lifecycle of 20 or 30 years. Investment firms have to think of short-term views as well,” he says.
Shamindra Perera, head of pensions solutions at Russell Investments, accepts it is not feasible for a scheme to wait 10 years for an answer on performance but says there has to be a trade-off. “Ultimately, you need to achieve short-term progress but not compromise solutions in the long term,” he says. “The real problem is that
the investment outcome is long term and the pension funds must measure in the short term. You need to be sure the tail is not wagging the dog.”
It can be helpful to have a third party involved for independent verification, says Sion Cole, head of client solutions at Aon Hewitt. “One portfolio might deliver in most environments and a third party can back up the fiduciary at those times when it doesn’t. They can help to manage expectations where the manager may be underperforming against short-term measurements.”
Of course, Cole adds, the third-party evaluators must be able to demonstrate they are truly independent and can add value themselves.
“There is lots of talk about fiduciary managers being in conflict, yet this exists on the consulting side, too,” he says. “Unless there are Chinese walls in place, there are clear conflicts. Third-party evaluators have also yet to demonstrate their business is economically viable and if they continue to run conflicts, their business models will be compromised.”
The importance of execution cannot be underestimated, according to chief executive of CREATE-Research Amin Rajan. “It is often said that 90% of returns come from asset allocation but this is not true,” he says. “The most important thing is execution.”
He adds that the development of investment solutions, particularly in the English-speaking world, is adopting what he calls an à la carte as opposed to a wholesale outsourcing approach, and this is defining how asset managers and consultants are developing their businesses.
Asset managers are good at using the right vehicles and risk-management tools for financial engineering, he says, whereas investment consultants will remain more involved in asset liability modelling and asset allocation. That does not mean there will not be a degree of divergence.
Rajan concludes: “We are going to see the largest managers with capabilities in execution and asset allocation treading on the toes of the consultants, and consultants will do the same to some asset managers. The rest will likely just stick to their knitting.
“Large pension plans will continue to look for specific alliances and specialist mandates but, at the smaller end, asset managers will be kept at arm’s length in an extension of core/satellite but moving away from traditional asset allocation to more solution-based approaches.”